So you’ve built a quality product that is being heavily consumed and a larger company is now seeking to acquire your startup. This blog post provides tips for avoiding common mistakes made by startup companies during acquisitions.

Avoiding Mistakes from the Start of Your Startup:

Founder Equity – Hold founder equity in your startup in the form of shares, not options. Startup founders can get the appreciation of their shares taxed at capital gain rates. Conversely, options typically result in the appreciation being taxed at ordinary income rates, which are now higher and lead to less money in your pocket.

Document Organization – To avoid the difficulties arising from a lack of a strong and secure record keeping strategy, your startup founders should initiate the creation of a virtual data room when the business is still in its early stages to ensure thorough accounting of all corporate and financial records. Scan all of your agreements and file them electronically in an organized way!

Protect Your IP – Startup leaders can protect your company’s IP by filing for patent protection, utilizing virtual data rooms to house trade secrets, and limiting dissemination of company information. You should also ensure that all IP is properly assigned to the buyer when the deal closes.

Avoiding Mistakes in Negotiations:

Keep Your Options Open – Leave yourself with alternatives to the buyers your startup is targeting to maximize price. If a buyer knows that you want to make a deal but only have one alternative, then the price will drastically drop.

Early Negotiation of Employment Agreements – Bring up employment and non-compete agreements as soon as possible in negotiations with a buyer. If these are not negotiated until the last minute, a lot of pressure is put on startup founders to sign, so terms may be less favorable than they would be.

Price Adjustments Impact Negotiations – Be sure to understand all price adjustments when negotiating price. Such adjustments include escrows, legal fees, balance sheet adjustments, and special indemnities. Once your startup signs a no shop agreement in a term sheet, all of the power shifts to the buyer. It would be a nightmare to learn at that point that the price the buyer said they would pay is before several price deductions.

Compensation to Avoid – Avoid selling your startup for private company shares in a taxable transaction. Typically, the market for private company shares is nonexistent (as they are not publicly traded). Therefore, obtaining and paying taxes on the buyer’s private shares in an acquisition leaves you with an out-of-pocket cost and nothing to show for it, with the exception of some shares that you cannot sell. Structure the transaction so that it’s all cash or so that the receipt of the buyer’s shares is nontaxable, at least until you sell those shares.

Have a Transition Plan – Make clear how the transition will unfold, including who will oversee what, deadlines for tasks and milestones to be completed, and how integration will be effectively achieved.

Who’s in Charge – This falls under the umbrella of having a transition plan, but is important enough to be entitled to its own bullet point. Be sure to determine which company will run things after the acquisition. In the short-term, it often makes sense for the startup’s management team to continue to run things because you know what you’re doing. On the other hand, for the acquisition to ultimately be successful down the road, many people think that the product acquired must be run the way the buyer runs things. Pick who will run things on day 1 and align incentives to maximize success of the chosen route.

Transferring IP – Ensure that all of your startup’s IP is properly assigned to the buyer when the deal closes.

Although these best practices are not foolproof, they can help increase the likelihood that the acquisition of your startup is both successful and satisfactory.